Scarce Resources

By Dan McLaughlin, on December 29th, 2008

“There is more than one way to skin a cat.” That old saying it is a very appropriate basis for understanding resource economics.

People use particular resources only for the services they provide, not because of any intrinsic value of the resources. People use copper because it conducts electricity or heat, is malleable or displays many other useful qualities. Petroleum is used because it powers vehicles, provides heat, light and power, and can be transformed into a huge variety of plastics and useful chemicals. Iron, gold and, indeed, all physical resources, have certain measurable characteristics which human ingenuity can use to solve the many problems of living healthy, comfortable lives.

Gasoline is only one means to an end. Before the advent of internal combustion engines, there were other modes of transportation which people used, because they were the best, most efficient choices at the time. Horses, mules and wagons provided local transportation services for a long time. The horse was valuable primarily because of the service it provided. When motor vehicles took over their role, horses became less scarce and less valuable, even though their numbers declined.

Whale oil was used for lighting before kerosene. It was very scarce, and thus, very expensive. The dawn of kerosene as a cheap, plentiful substitute for the service of providing light made whale oil too expensive, and it quickly lost out to the new, more efficient rival. Cheap electricity subsequently took over the lighting role played by kerosene.

The idea of scarce resources only makes sense when there is a human use for them. Before the beneficial properties of oil were discovered, nobody ever considered petroleum scarce. It was, rather, a considerable nuisance wherever it was found. The instant that people discovered the valuable products that could be made from it, it became a scarce resource.

A resource is only scarce if there is not enough to provide for all of the demand for its useful properties. Scarcity is relative. It is a function of how much is readily available in relation to how many people want it and the size of the problems it solves. Whale oil may be very rare these days, but most people would not say there is any scarcity of it. We have no need for it because its useful properties have been provided much more efficiently and cheaply by substitutes.

If you want to know how scarce a good is, you only need to look at its price. That is the most reliable gauge of scarcity. In the absence of intervention in the market, the more scarcity, the higher the price. Diamonds and platinum are very expensive because there aren’t enough of them. Their physical characteristics make them very desirable, so people are willing to pay a high price for them. If new sources of supply were found and they became readily available, the prices would drop, not because they were less useful, but because they became less scarce, relative to the demand for their useful qualities.

With that in mind, one of the most fascinating phenomena related to human civilization becomes more understandable. Even as there are more people using more resources year after year, there is less and less scarcity. While prices of resources may fluctuate significantly in the short run, in the long run, there is a very real trend toward falling prices and less scarcity of virtually all resources. There is no credible reason to believe that that trend will suddenly reverse.

That may not be the case in every geographic area for every resource at every time. In some places, resources such as water may become more scarce. From an overall perspective, however, there is no less water in the world than there was a million years ago. The only water we have lost has been from transporting it out of our atmosphere with the space program. The same goes for virtually every other chemical substance on earth. Humans need to locate where there is plenty of usable water, or to efficiently purify it or transport it to other places where they want to go. The problem with water is that people typically think that it should be provided cheaply or for free by government, and thus, market prices do not guide responsible action.

Declining scarcity of resources, even as they are used, makes sense when you recognize that it is not the resource itself, but rather its useful properties, that people buy. If one resource gets too expensive due to scarcity, people use less of it or develop more efficient methods of getting the same benefits. The higher price makes it more profitable, and the higher profits draw competitors to develop more of the resource. The higher price also makes alternative ways of providing for human needs more attractive.

The opposite dynamic occurs in the case of high availability and low prices. Producers develop more efficient methods of production and distribution so they can remain profitable. Those improvements carry over into times of greater scarcity, and the net result is that prices continue to fall over time while long term scarcity declines.

We see those opposing processes happening on a continuing basis. In the case of petroleum products, higher prices encouraged more conservation efforts, more efficient technology and increased exploration and development. It also made alternative forms of energy more profitable and promoted their development. There is less scarcity of oil lately, due to lower demand, and thus, significantly lower prices. Producers are trying to become more efficient in order to stay profitable. Society benefits because the cost of energy is less than it would have been had the consumer and producer improvements not been made over time.

Some day it is possible that petroleum could become the whale oil of tomorrow, becoming too expensive for economical use. But there is more than one way to skin the cat of heating, lighting, transportation and manufacturing needs. The most efficient forms of energy will ultimately win out, and in the long run, the cost of energy will continue its long and relentless trend to less scarcity and lower prices, just like every other form of natural resource throughout the course of human civilization.

2 comments to Scarce Resources

Good article, Dan. One of the factors I feel is overlooked in most considerations of this current financial crisis is that the substitutionary effect on prices that can moderate inflation has been underappreciated. As soon as a price increases more than, say, 5% a year, talk arises of a “bubble” or a “shortage”. Yet, it is these kinds of price increases that can affect the economy the way you expect.

Substitution has to overcome many factors: inertia- “this is how we’ve always done it”, ROI considerations- will the price stay high enough to justify the investment, and time- some things just take awhile to develop.

One example would be a computer program ran by someone like Google, Ebay, or Craigslist that would allow people to enter personal ID data (perhaps using biometrics and a cell phone), desired route of travel, and a time window, and then rideshares would be automatically suggested. This would have the effect of cutting demand (and expense) for petroleum significantly.

But this takes time to get traction, and for problems to be solved in implementation. Meanwhile, if someone intervenes to lower gas prices significantly, the return is reduced. After this has happened a few times, just the risk of this intervention will reduce investment. And when the intervention comes in the form of interest rate hikes, creating 2 and 3X cash flow impacts (don’t forget, for every dollar of debt service the bank wants to see an additional dollar of profit to maintain ratios), this creates a powerful double whammy that has the potentiall to knock us back to the stone age.

I’m still saddened that we don’t hear that it was Fed interest rate hikes that created this mess, although you don’t hear too many people talk about how it was the cheap money of the 2002-2004 period that created it as much as we did 6 months ago. Because we’ll never create confidence in investment and resource replacement/obviation (think wireless for copper) until investors have some confidence that the Fed can’t confiscate their profits with future significant hikes and monetary constraint.